Franking credits: If you smell a rat, you're right

10 March 2019 | Newcastle Herald

The technical language used in the furore over dividend franking credits may be confusing to some. If you don’t really understand the issue but still smell a rat, you are right.

To put it at its simplest, dividends are paid out of profits. If companies have paid 30 per cent tax on those profits, then under our dividend imputation system that tax is attributed (“imputed”) to the shareholders. This is done by distributing credits (franking credits) for the tax paid along with the dividends.

Shareholders then pay tax on the dividends plus the franking credits, at whatever their tax rate is — but get a tax credit equivalent to the franking credit. If their tax rate happens to be 30 per cent, it’s all a wash and they pay no more, or less. Otherwise they pay more, or less.

The purpose of all this shuffling is to avoid double taxation of the same dollar at both the company and the personal (or super fund) level. If the shareholder has enough other taxable income apart from the dividends and franking credits, they will have a tax liability that is reduced by the franking credits. They will still pay tax, but less.

If the shareholder has no other income and is on a zero tax rate (either an individual below the tax-free threshold or a super fund paying a pension) the franking credits are said to be “excess” and are refunded as cash. It is these cash refunds the Labor Party wants to stop — or at least for some taxpayers, not all.

Excess franking credits were not refunded until 2000. The policy shift to allow refunds was introduced by the Howard government and supported by the Labor opposition at the time. The Labor governments of 2007-13 did not stop the practice.

Parties are entitled to change their minds, but only if they have good reason. Increasingly, as the debate about franking credits has heated up, the opposition has focused on one proposition: that if a shareholder has no tax liability, there cannot legitimately be a refund of tax … like many sound bites, it is unsound.

Fast forward to 2019 and Bill Shorten now says it is “crazy” to pay refunds.

Political parties are entitled to change their minds, but only if they have good reason. Increasingly, as the debate about franking credits has heated up, the opposition has focused on one proposition: that if a shareholder has no tax liability, there cannot legitimately be a refund of tax.

That might make for a good sound bite but, like many sound bites, it is unsound.

Under the logic of the dividend imputation system, even the zero rate taxpayer is deemed to have paid their share of tax at the company level. If it’s not refunded to them, they are no longer zero rate taxpayers.

There are legitimate arguments about whether the imputation system best serves Australia’s economic interests, but that is a different issue. For as long as we have it, cash refunds are as much a legitimate part of the system as are tax credits against other tax payable by shareholders.

I suspect Chris Bowen and his colleagues know all that, and have other motives for stopping refunds.

The first one is revenue. They want lots of it to fund spending promises, and stopping franking credit refunds (for some individuals and funds) will generate a large dollop of it fairly quickly.

The second reason is they don’t like the idea of anyone other than very low income people being on a zero tax rate. Rather than change that directly, taking away franking credits is an indirect way of achieving the same outcome and limiting the damage to a group they can portray as “undeserving” — self-funded retirees.

The third reason is that they see political value in hitting those retirees with higher taxes — just as they see political value in hitting banks with more levies and the NSW opposition leader sees political value in hiking taxes on luxury cars and boats.

It all fits in to the supposed “fairness” narrative. It’s not that self-managed retirees are necessarily well-off — indeed, many of them are struggling to stretch out their savings in today’s economic climate.

But Labor is happy to spin the perception that self-funded retirees are all wealthy. And punish them in the name of politics.

Robert Carling is a former IMF and federal and state treasury economist, and a senior fellow at the Centre for Independent Studies